Planning Your Cash Flow: The Three Types of Budgeting to Start Afresh
By Abbas Somji
Budgeting – it seems so simple in theory. You say how much you want to spend and don’t spend anymore. Easy? Well, yes, in theory. The bigger question is: how do you budget? Do you put a number to each and every category? Do you have one large number and forget the categories? Should you have a spreadsheet? Do you spend from a debit or credit card?
So many questions! There is no one size fits all approach. It depends on you and how you feel most comfortable. However, the most important tool in budgeting is to remember to pay yourself first – and that means saving. Plan on how much to save and where. Once you’re hitting this target, the rest of your budget falls into place. It’s the basis of every effective Financial Plan. It does however require a shift on how to approach the order of budgeting from the current method to the most effective method.
There are three common budgeting strategies that work best – which one depends on how you like to see information:
- Envelope Approach
- Monthly Allowance
- Spend down a large bucket while your income pays to a separate account
Strategy 1: Envelope Approach – Categorize and Create Separate Accounts
The first method takes the most amount of work, but it’s also the most detailed and accurate way of tracking your spending. Create an excel spreadsheet or sign up for an expense tracking app (Money Dashboard, Emma, Goodbudget, etc.) or use a banking app that categorizes everything for you. The purpose of this method is to know how much you’re spending on food, clothing, transport, entertainment, groceries, etc. and to create an allowance for each category and not spend any more than the budget each month. This is a great way to track your expenses if you enjoy the detail. You’ll probably be one of the few who know exactly what they’re spending on each category, and you’re probably an engineer!
This strategy requires different buckets within your current account that account for your largest expenses like travel, monthly transport and food, savings, etc. It can quickly become a lot of accounts to keep track off for most people, and potentially a nightmare for FBARs.
Strategy 2: Monthly Allowance
This is more than likely the approach that suits most people. I use this method too. Calculate how much you want to spend monthly outside of your Direct Debit expenses (rent, utilities, council taxes, etc.) and spend it via credit card. What you spend on is not as important as staying below the monthly budget number. Doesn’t matter if you ate out one too many times, or treated yourself to a new pair of shoes – the principle is that you sacrifice in other categories to make it within budget. This is a great yet simple method of budgeting – but it does require awareness. Get into the habit of checking your credit card (or separate debit card) weekly to check your balance and progress.
If you’re using a credit card, pay it off monthly. If you’re using a debit card, fund that card with your budget monthly.
Pro tip – travel budget should be saved into a separate account and then used to pay-off excess on credit card in the months you travel or book travel (assuming you use a credit card to pay for larger purchases such as plane tickets).
Strategy 3: Spend down strategy
This requires a good amount of liquidity right off the bat. It’s even more vague than the first, but you fund an account upfront with the intention of that account lasting 6 months or 12 months. If you’re running out of that bucket sooner than it should last, you’re overspending, and you need to re-evaluate your expenses. You will need to go back to basics and detail out your expenses using the first method. It’s important to know where and what you’re spending on.
This method is usually best for those that pay for things in advance (rent in lump sums, insurances, travel cards, etc.).
There are multiple approaches to budgeting. To budget effectively, you need to find the method that works best for you, that stresses you out the least and allows you to follow a format. After a while of using these methods budgeting will become more of an instinct and you’ll be wondering less about whether you can or cannot afford something.
Remember, you don’t need to spend your entire budget in a given month. You don’t need to save it either. It can be used to help with larger purchases (Black Friday and Cyber Monday haul anyone?). Know your savings, don’t dip into your savings, and budget accordingly. Saving extra is great, but if you have an intentional savings plan as part of your Financial Plan in place then extra savings usually aren’t needed. It’s all about effective planning that works for you.
Abbas Somji – Financial Advisor – Link to Bio